The Fourth Circuit Court of Appeals reversed and remanded a district
court decision because the lower court permitted the jury to hear
evidence of a taxpayer’s failure to file his personal income tax
returns and to pay his taxes as evidence of his bad acts in
determining whether he should be subject to the Sec. 6700 penalty for
promoting an abusive tax shelter (Nagy,
No. 10-2072 (4th Cir. 3/29/13)). The jury had assessed a $2.636
million penalty against the taxpayer; the liability verdict and the
penalty have been vacated by the appeals court and remanded to the
lower court for a new trial.

The taxpayer, Robert Nagy, a CPA, had issued an opinion on the
Derivium 90% loan program, in which investors purportedly transferred
securities as “collateral” in return for a loan from Derivium of 90%
of the securities. His opinion stated that the transactions were
bona-fide loans and not sales of the securities. Derivium claimed it
would use the securities it received in hedging transactions and
return them when the investors repaid their loans, but the entire
program was in fact a Ponzi scheme in which Derivium immediately sold
the securities it received to continue perpetrating the scheme. Upon
investigation, the IRS determined that the 90% loans were actually
sales of the securities for tax purposes.

As a result of Nagy’s involvement in the scheme, the IRS assessed
penalties against him under Sec. 6700 for promoting a tax shelter. He
paid part of the penalty and sued for refund in district court. At
trial, the district court allowed the IRS to introduce as evidence
regarding his Sec. 6700 liability Nagy’s failure to file his personal
income tax returns and to pay his taxes.

According to the appeals court, the rules of evidence prohibit
evidence of a crime, wrong, or other act to prove a person’s character
to show that on a particular occasion the person acted in accordance
with that character. It agreed with Nagy, who argued that this
evidence was not relevant to his liability under Sec. 6700 for an
unrelated transaction and only served to cast him in a bad light.

The IRS claimed that evidence of his behavior in failing to file his
taxes at the same time he was issuing an opinion about the tax shelter
was relevant to show an absence of mistake in his tax advice. The
appeals court found that there was no relationship between the two
transactions (his returns and the tax shelter) and that the evidence
was so prejudicial (and was not harmless error) that it must be
excluded on remand. It held that the district court had abused its
discretion in admitting the evidence and therefore vacated the
liability and penalty verdicts.

As for the other five issues on appeal, Nagy was not as successful.
The appeals court upheld the district court’s granting summary
judgment on the issue whether the 90% loans were sales and not loans
for tax purposes, and it upheld the lower court’s decision to exclude
certain testimony Nagy wanted to submit. It found that he had failed
to timely object to the lower court’s jury instruction stating that
the 90% loans were sales and not loans was “a false or fraudulent
statement as a matter of law” under Sec. 6700.

On the final issue, whether the lower court gave erroneous
instructions for calculating the penalty (if it is determined to apply
on remand), the appeals court gave specific jury instructions for how
the penalty should be calculated.

TAX NEWS

President Barack Obama signed legislation that retroactively extended more than 50 expired tax provisions for 2014, allowing taxpayers to take advantage of a host of tax incentives during this filing season.

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